Building Wealth (2024)

Do you know how to set a budget?

If you haven’t yet, read about budgeting to save in Chapter 2, before learning about saving and investing.

You have budgeted and identified an amount to save monthly.

Investing is putting the money you save to work, increasing your wealth. An investment is anything you acquire for future income or benefit. Investments increase by generating income (interest or dividends) or by growing (appreciating) in value. Income earned from your investments and any appreciation in the value of your investments increase your wealth.

There is an art to choosing ways to invest your savings. Good investments will make money; bad investments will cost money.

Do your homework. Gather as much information as you can. Seek advice from licensed or registered advisers. States require licensing or registration for brokers, investment advisers and insurance salespeople, so check with your state securities regulator before trusting any investment adviser.

Also, check out the Wealth-Building Resource Guide for helpful sites.

• Save money on check cashing fees and money orders.
• Take advantage of compound interest, with no risk.
• Keep your money safer than in your pocket or at home.
• Take advantage of direct deposit of your paycheck.
• Monitor your balance online (and on your smartphone).
• Access your money from anywhere at any time.
• Easily move money from one account to another.
• Build a banking relationship, which is important to your credit history.
• Have your savings insured by the FDIC (NCUA for credit unions) up to $250,000.

Financial institutions offer a variety of insured savings accounts, each of which pays a different interest rate. Among them are:

• General savings accounts, which earn interest and allow access to funds at any time and movement of money from account to account.
• Money market accounts, which earn interest, may offer check-writing services and impose no fees with a minimum balance.
• Certificates of deposit (CDs), which are purchased for a specified term and return principal and interest at the end of the term (early withdrawal penalties apply).

When you buy bonds, you are lending your money to a federal or state agency, municipality or other issuer, such as a corporation. A bond is like an IOU. The issuer promises to pay a stated rate of interest during the life of the bond and repay the entire face value when the bond comes due or reaches maturity. The interest a bond pays is based primarily on the credit quality of the issuer and current interest rates. Firms like Moody’s Investor Service and Standard & Poor’s rate bonds. With corporate bonds, the company’s bond rating is based on its financial picture. The rating for municipal bonds is based on its financial picture. The rating for municipal bonds is based on the creditworthiness of the government or other public entity that issues it. Issuers with the greatest likelihood of paying back the money have the highest ratings, and their bonds will pay an investor a lower interest rate. Remember, the lower the risk, the lower the expected return.

A bond may be sold at face value (called par value) or at a premium or discount. For example, when prevailing interest rates are lower than the bond’s stated rate, the selling price of the bond rises above its face value. It is sold at a premium. Conversely, when prevailing interest rates are higher than the bond’s stated rate, the selling price of the bond is discounted below face value. When bonds are purchased, they may be held to maturity or traded.

When you buy common stock, you become a part owner of the company and are known as a stockholder, or shareholder. Stockholders can make money in two ways—receiving dividend payments and selling stock that has appreciated.

• A dividend is an income distribution by a corporation to its shareholders, usually made quarterly.
• Stock appreciation is an increase in the value of stock in the company, generally based on its ability to make money and pay a dividend. However, if the company doesn’t perform as expected, the stock’s value may go down.

There is no guarantee you will make money as a stockholder. In purchasing shares of stock, you take a risk on the company making a profit and paying a dividend or seeing the value of its stock go up. Before investing in a company, learn about its past financial performance, management, products and how the stock has been valued in the past. Learn what the experts say about the company and the relationship of its financial performance and stock price. Successful investors are well-informed.

Mutual funds are established to invest many people’s money in many firms. When you buy mutual fund shares, you become a shareholder of a fund that has invested in many other companies. By diversifying, a mutual fund spreads risk across numerous companies rather than relying on just one to perform well. Mutual funds have varying degrees of risk. They also have costs associated with owning them, such as management fees, that will vary depending on the type of investments the fund makes.

Before investing in a mutual fund, learn about its past performance, the companies it invests in, how it is managed and the fees investors are charged. Learn what the experts say about the fund and its competitors.

Stocks, bonds and mutual funds can be purchased through a full-service broker if you need investment advice, or from a discount broker or even directly from some companies and mutual funds.

The Rule of 72 can help you estimate how your investment will grow over time. Simply divide the number 72 by your investment’s expected rate of return to find out approximately how many years it will take for your investment to double in value.

Example: Invest $5,000 today at 8 percent interest. Divide 72 by 8 and you get 9. Your investment will double every nine years. In nine years, your $5,000 investment will be worth about $10,000, in 18 years about $20,000 and in 27 years, $40,000.

The Rule of 72 also works if you want to find out the rate of return you need to make your money double. For example, if you have some money to invest and you want it to double in 10 years, what rate of return would you need? Divide 72 by 10 and you get 7.2. Your money will double in 10 years if your average rate of return is 7.2 percent.

An individual retirement account (IRA) lets you build wealth and retirement security. The money you invest in an IRA grows tax-free until you retire and are ready to withdraw it. You can open an IRA at a bank, brokerage firm, mutual fund or insurance company.

IRAs are subject to certain income limitations and other requirements you will need to learn more about, but here is an overview of what they offer, with the maximum tax-free annual contributions as of 2021.

Traditional IRA

Roth IRA

A Roth IRA is funded by after-tax earnings; you do not deduct the money you pay in from your current income. However, after age 59½ you can withdraw the principal and any interest or appreciated value tax-free.

Many companies offer a 401(k) plan for employees’ retirement. Participants authorize a certain percentage of their before-tax salary to be deducted from their paycheck and put into a 401(k). Many times, 401(k) funds are professionally managed and employees have a choice of investments that vary in risk. Employees are responsible for learning about the investment choices offered.

By putting a percentage of your salary into a 401(k), you reduce the amount of pay subject to federal and state income tax. Tax-deferred contributions and earnings make up the best one-two punch in investing. In addition, your employer may match a portion of every dollar you invest in the 401(k), up to a certain percentage or dollar amount.

As long as the money remains in your 410(k), it’s tax-deferred. Withdrawals for any purpose are taxable, and withdrawals before age 59½ are subject to penalty. Take full advantage of the retirement savings programs your company offers—and understand thoroughly how they work. They are great ways to build wealth.

If you’re self-employed, don’t worry. There is a retirement plan for you.

A qualified plan (formerly referred to as a Keogh plan) is a tax-deferred plan designed to help self-employed workers save for retirement.

The most attractive feature of a qualified plan is the high maximum contribution—up to $58,000 annually. The contributions and investment earnings grow tax-free until they are withdrawn, when they are taxed as ordinary income. Withdrawals before age 59½ are subject to a penalty.

Check the IRS website—www.irs.gov—for current information on tax-deferred investments.

Remember, when investing:

• Make sure you know and understand all the costs associated with buying, selling and managing your investments.
• Have savings automatically deducted from your paycheck or checking account.
• Beware of investments that seem too good to be true; they probably are.
• Investigate financial professionals before you invest. Your state securities board provides free services to check credentials.

In other words, get on automatic pilot and stay there.